adb-financial project analysis

Foreword ADB’s Charter (the Agreement Establishing the Asian Development Bank, August 1966) places a clear fiduciary responsibility upon ADB to ensure that projects are financially viable and sustainable, that funds are used for their intended purpose and that the Borrower has the capacity to fulfill obligations under the loan agreements. Financial management and analysis of ADB projects has been conducted since ADB was founded. To improve the uniformity, approach, and coverage of financial analysis, ADB issued Guidelines for the Preparation and Presentation of Financial Analysis in 1989. Over time, the Guidelines have been periodically reviewed and amended to reflect the changing environment in which ADB operates. The Guidelines describe ADB's philosophy, policies, and approach to financial management of executing agencies and financial analysis of investment projects. They have been prepared for the benefit of ADB staff and consultants who evaluate financial management practices of executing agencies and undertake financial analysis of investment projects. The new title—Financial Management and Analysis of Projects—reflects changes in ADB policies and procedures since 2000. In particular, it reflects renewed appreciation that sound financial management in executing agencies is a key determinant of financial sustainability. ADB deals with countries and sectors that are at different stages of development and that have different resources, and capacities. Recognizing this, the Guidelines need to be applied in a realistic, practical, and flexible manner. ADB financial analysts and financial management specialists have the discretion to determine the extent to which the Guidelines will apply in particular circumstances. The advice, directions and recommendations in the Guidelines should not be regarded as a substitute for initiative. ADB staff should always exercise resourcefulness and imagination in reaching sound professional judgments. GEERT VAN DER LINDEN Vice President Knowledge Management and Sustainable Development July 2005 Financial Management and Analysis of Projects iii Key Information on these Guidelines What are these Guidelines? The Asian Development Bank (ADB) publishes the Financial Management and Analysis of Projects (the Guidelines). The Guidelines set out ADB’s requirements and procedures for the financial management of projects financed by ADB, for instance, financial reporting, and auditing requirements. They also provide guidance on how to apply these requirements. When are the Guidelines updated? The Guidelines are available as a downloadable document (abridged), via lotus notes, on the intranet at http://intra.asiandevbank.org/fmguide/ and on CD-ROM. The Guidelines are also available in the internet at www.adb.org/documents/guidelines/financial . The web-based Guidelines and the downloadable copy of the Guidelines are updated. A list of changes to the Guidelines can be accessed online. After reviewing these changes, users may decide to download an uptodate copy of the Guidelines from the website. What recent changes have been made to the Guidelines? ADB’s 1989 Guidelines were reviewed and re-released in November 2001. The changes to the 2001 Guidelines reflected developments in financial management practices, changes in accounting and auditing standards, and harmonization efforts by the multilateral development banks, including ADB. The Guidelines were further reviewed, and technical adjustments made in 2005. Who can I ask for help on the Guidelines? If your question is related to a project or program, please contact the responsible ADB project officer in the first instance. Otherwise, contact: Principal Financial Management Specialist Asian Development Bank Manila, Philippines General Information: fmguidelines@adb.org Webmaster: fmgwebmaster@adb.org Telephone (632) 632-6651 Fax: (632) 636-2365 Postal: ADB Avenue P.O. Box 789, 0980, Manila, Philippines. Financial Management and Analysis of Projects iv Acronyms The following acronyms are used throughout these Guidelines. A fuller list of common ADB acronyms is accessible at www.adb.org . ADB Asian Development Bank ADF Asian Development Fund AfDB African Development Bank APA audited project accounts BCBS Basle Committee for Banking Supervision (BIS) BIS Bank for International Settlements BTOR back-to-office report CAPA Confederation of Asian and Pacific Accountants CFAA Country Financial Accountability Assessment (World Bank) CFS Corporate Financial Statements COSO Central Operations Services Office CPA Certified Public Accountant CSP country strategy program DMC Developing Member Country DSAA Diagnostic Study of Accounting and Auditing EA Executing Agency EBRD European Bank for Reconstruction and Development ED exposure draft EIRR economic internal rate of return ENPV economic net present value EU European Union FARAH Financial Accounting, Reporting and Auditing Handbook (World Bank) FASB Financial Accounting Standards Board (United States) FCDD financial charges during development FI Financial Institution FIL financial institution loan FIRR financial internal rate of return FNPV financial net present value FOCC financial opportunity cost of capital GAAP Generally Accepted Accounting Principles GDP Gross Domestic Product IA Implementing Agency (also PIU) IAASB International Audit and Assurance Standards Board IADB Inter-American Development Bank IAPC International Auditing Practices Committee (IFAC) IAPS International Auditing Practice Statement (issued by IAPC) IAS International Accounting Standards (issued by IASB) Financial Management and Analysis of Projects v IASB International Accounting Standards Board (formerly IASC) IASC International Accounting Standards Committee IEG International Education Guideline (issued by IFAC) IES International Education Standard (issued by IFAC) IFAC International Federation of Accountants IFRS International Financial Reporting Standard (issued by IASB) IMF International Monetary Fund INTOSAI International Organization of Supreme Audit Institutions IOSCO International Organization of Securities Commissions IPSAS International Public Sector Accounting Standard (issued by IFAC) ISA International Standards on Auditing (issued by IAPC) LIBOR London interbank offered rate MDB Multilateral Development Bank MFI microfinance institution MIGA Multilateral Investment Guarantee Agency MOF Ministry of Finance MRM Management Review Meeting NGO Nongovernment Organization OCR ordinary capital resources OECD Organization for Economic Cooperation and Development OIST Office of Information Systems and Technology OM Operations Manual PAI Project Administration Instructions PAU Project Administration Unit PCR Project Completion Report PIU Project Implementing Unit (also IA) PMU Project Management Unit PPTA Project Preparatory Technical Assistance PSC Public Sector Committee (IFAC) PSOD Private Sector Operations Department REEA Revenue Earning Executing Agency RETA Regional Technical Assistance ROE return on equity ROR rate of return ROSC Report on the Observance of Standards and Codes (World Bank–IMF) RRP Report and Recommendation of the President (ADB) SAI Supreme Audit Institution SFR self-financing ratio SI sensitivity indicator SME small-medium-scale enterprise SOE Statement of Expenditure SRC Staff Review Committee TA Technical Assistance Financial Management and Analysis of Projects vi TOR Terms of Reference UNCTAD United Nations Conference on Trade and Development WACC weighted average cost of capital WTO World Trade Organization Financial Management and Analysis of Projects Contents 1. Introduction to the Guidelines 1.1. Introduction 1.2. Rationale 1.3. Objectives 1.4. Structure 1.5. Project File 1.6. Guideline Updates 1.7. Roles of Financial Analysis Specialists and Financial Management Specialists 2. User Instructions 2.1. Overview 2.2. ADB Lending and Technical Assistance 2.3. Applying these Guidelines 2.4. Project Types and General Treatments 2.5. Overview of Project Processing Steps 2.6. Step 1: Identification and Early Preparation 2.7. Step 2: Loan Preparation 2.8. Step 3: Project Examination 2.9. Step 4: Loan Negotiations 2.10. Step 5: Project Implementation 2.11. Step 6: Project Completion 3. Preparing and Appraising Investment Project 3.1. Investment Projects Overview 3.2. Possible Investment Projects 3.2.1. Possible Revenue-Earning Projects 3.2.2. Possible Nonrevenue-Earning Projects 3.3. Appraisal Checklists 3.4. Forecasting 3.4.1. Introduction to Forecasting 3.4.2. Using the COSTAB Model 3.4.3. Preparing Project Cost Estimates 3.4.4. Determining Contingencies 3.4.5. Disbursement Profiles 3.4.6. Preparing Financing Plans 3.4.7. Computing Incremental Project Cash Flows 3.5. Preparing Financial Benefit-Cost Analyses 3.5.1. Introduction 3.5.2. Determining the Discount Rate– WACC 3.5.3. Calculating the Financial Internal Rate of Return and Net Present Value 3.5.4. Undertaking Sensitivity and Risk Analyses 3.6. Loan Covenants 3.6.1. Introduction to Loan Covenants 3.6.2. Operating Covenants 3.6.3. Capital Structure Covenants 3.6.4. Liquidity Covenants 3.7. ADB Reports 3.7.1. Introduction to ADB Reports 3.7.2. Project Preparatory Technical Assistance Stage 3.7.3. Report and Recommendation of the President 3.7.4. Miscellaneous ADB Reports 4. Financial Management of Executing Agencies 4.1. Financial Management Overview 4.2. Institutions and Systems 4.2.1. Introduction to Institutions and Systems 4.2.2. Major Institutional Assessments 4.2.3. Governance 4.2.4. Financial Management and Governance Arrangement 4.2.5. Country Diagnostic Studies of Accounting and Auditing 4.2.6. Executing Agencies 4.2.7. Project Objectives 4.2.8. Revenue-Earning Projects 4.2.9. Nonrevenue-Earning Projects 4.3. Financial Analysis 4.3.1. Introduction to Financial Analysis 4.3.2. Financial Analysis Objectives 4.3.3. Linkages with Cost Recovery and Tariffs 4.3.4. Preparing Financial Tables 4.3.5. Determining Fiscal Period Coverage 4.3.6. Forecasting and Financial Projections 4.3.7. Forecasting Assumptions Financial Management and Analysis of Projects viii 4.4. Measuring Performance 4.4.1. Introduction to Measuring Performance 4.4.2. Objectives of Measuring Performance 4.4.3. Performance Indicators 4.4.4. Using Benchmarking Indicators 4.4.5. Selecting Indicators and Covenants 4.4.6. Operating Indicators and Covenants 4.4.7. Capital Structure Indicators 4.4.8. Liquidity Indicators 5. Reporting and Auditing 5.1. Financial Reporting and Auditing Overview 5.2. Accounting Standards and Policies 5.2.1. Introduction 5.2.2. International Accounting Standards 5.2.3. ADB Accounting Policy Requirements 5.3. Financial Reporting 5.3.1. Introduction 5.3.2. Content and Timing of Financial Reporting 5.3.3. Accounting Statements and Financial Reports 5.3.4. Interim Financial Statements and the Project Management Report 5.3.5. Audited Project Financial Statements 5.3.6. Annual Financial Statements for a Nonrevenue-Earning Project 5.3.7. Annual Financial Statements for Revenue-Earning Projects and EAs 5.3.8. Supplementary Financial Statements 5.3.9. Designing Financial Reports for Revenue-Earning Projects 5.3.10. Designing Financial Reports for Nonrevenue-Earning Projects 5.3.11. Examples of Model Financial Statements 5.4. Auditing Standards and Auditor Engagement 5.4.1. Introduction 5.4.2. ADB Requirements 5.4.3. Auditing Procedures 5.4.4. Auditor Selection and Appointment 5.4.5. Issues in Auditor Selection 5.4.6. Selecting Auditors 5.4.7. Terms of Reference for an Auditor 5.4.8. Contract or Engagement Letter of Auditor 5.4.9. International Standards on Auditing 5.4.10. Government Auditors 5.5. Reviewing Financial Reports 5.5.1. Introduction 5.5.2. Review Process: Late or Unacceptable Financial Reports 5.5.3. Compliance with Financial Performance Covenants 5.5.4. Communication with Government Auditors 5.6. Reviewing Auditors’ Reports 5.6.1. Introduction 5.6.2. Auditors’ Reports and Opinions 5.6.3. Model Audit Opinions 5.6.4. Compliance with Loan Covenants 5.6.5. Compliance with ADB’s Requirements 5.6.6. Types of Auditors’ Opinion 5.6.7. Materiality 5.6.8. Use of Technical Experts 5.6.9. Statements of Expenditure and Imprest Accounts 5.6.10. Reviewing Audit Management Letters 5.6.11. Audit Report Questionnaire 6. Financial Institutions 6.1. Introduction and Overview 6.2. Reviewing FI Financial Management 6.2.1. General Operational Issues 6.2.2. Policy Framework for FIs and FI Loans 6.2.3. Treatment of Interest Rate Distortions 6.2.4. Treatment of Directed-Credit Programs 6.2.5. ADB Policy on Subsidies 6.2.6. Eligibility Criteria for FIs 6.3. FI Investments 6.3.1. Introduction Financial Management and Analysis of Projects ix 6.3.2. Investing in FIs 6.3.3. Selecting Participating Institutions 6.3.4. Appraising an FI Investment 6.4. Assessing FI Performance 6.4.1. Introduction 6.4.2. Assessing Microfinance Institutions 6.4.3. Applying the CAMEL Framework 6.4.4. Assessing FI Risks 6.4.5. Determining FI Credit Ratings 6.4.6. Specialized FI Internal Controls 6.5. Appraisal Checklist 6.6. FI Reporting and Auditing Issues 6.6.1. Introduction 6.6.2. FI Financial Reporting 6.6.3. FI Auditing 6.6.4. MFI Financial Reporting and Auditing 7. Knowledge Management 7.1. Useful Websites 7.2. Operations Manual (OM) 7.3. Project Administration Instructions (PAIs) 7.4. International Standards 7.5. International Accounting and Auditing Architecture 7.6. Financial Review Checklist for RRPs 7.6.1. Lessons from Past Projects 7.6.2. Project Cost Estimates 7.6.3. Financing Plan (FP) 7.6.4. Executing Agencies and Implementing Agencies 7.6.5. Financial Projections 7.6.6. Financial Analyst 7.6.7. Project Justification 7.6.8. Accounting and Auditing 7.6.9. Procurements and Disbursement Arrangements 7.6.10. Financed-Related Risk 7.6.11. Assurances 7.7. Appraisal Checklist: Nonrevenue-Earning Project 7.8. Appraisal Checklist: Revenue-Earning Project 7.9. Appraisal Checklist: Private Sector Project 7.10. Appraisal Checklist: Financial Institution 7.11. Undertaking Sensitivity and Risk Analyses 7.11.1. Step 1: Identify the Key Variables 7.11.2. Steps 2 and 3: Calculate Effects of Changing Variables 7.11.3. Step 4: Analyze Key Variable Changes 7.11.4. Undertaking Risk Analysis 7.12. Model Operating Covenants 7.12.1. Rate of Return (see 3.6.2.2) 7.12.2. Self-Financing Ratio (see 3.6.2.3) 7.12.3. General Price Level (see 3.6.2.4) 7.12.4. Operating Ratio (see 3.6.2.5) 7.12.5. Breakeven Covenant (see 3.6.2.6) 7.13. Model Capital Structure Covenants 7.13.1. Debt Service Coverage (Version A: Historical orientation) (see 3.6.3.3) 7.13.2. Debt Service Coverage (Version B: Forecast orientation) (see 3.6.3.3) 7.13.3. Debt-Equity Ratio (see 3.6.3.4) 7.13.4. Capital Adequacy Ratio (see 3.6.3.6) 7.14. Model Liquidity Covenants 7.14.1. Current Ratio (see 3.6.4.2) 7.14.2. Quick Ratio Covenant (see 3.6.4.3) 7.14.3. Dividend Limitation (see 3.6.4.4) 7.15. Commonly Used Ratios 7.15.1. Operating Indicators 7.15.2. Capital Adequacy Indicators 7.15.3. Liquidity Indicators 7.16. Model Financial Statements: Service Organization 7.17. Model Financial Statements: Manufacturing Organization 7.18. Model Terms of Reference for an Auditor 7.19. Audit Report Questionnaire 7.19.1. Using the Audit Report Questionnaire 7.19.2. Authenticity, Form, and Timeliness 7.19.3. Audit Opinion 7.19.4. Matters Addressed 7.19.5. Auditor’s Opinion and Report 7.19.6. Conclusion and Further Action (if any) Knowledge Management - Addendum Revisions Glossary Topical Index 1. Introduction to the Guidelines 1.1. Introduction 1.1.1. The vision of the Asian Development Bank (ADB) is a poverty-free Asia and Pacific region. ADB strives to be an effective partner for its Developing Member Countries (DMCs) in Asia and the Pacific in responding to the challenges of achieving sustained and equitable development, improving the quality of life, and eradicating poverty. ADB recognizes that sustained pro-poor growth, social development, and good governance are essential for poverty reduction. This vision reflects the belief that unleashing the potential of the poor will substantially contribute to overall growth and enhance the quality of life for all. 1.1.2. The Financial Management and Analysis of Projects (the Guidelines) serve two purposes. First they provide guidance to ADB staff and borrowers on the financial due diligence activities to be completed as part of the project appraisal process, namely financial analysis and financial management assessment. Second, they describe and explain ADB’s policies, procedures, and approach to the financial management of the projects that it finances. They replace ADB’s Guidelines for the Preparation and Presentation of Financial Analysis that were first published in 1989. In addition to providing guidance on ADB’s financial due diligence activities, the Guidelines contain business processes and good practice examples of financial management and financial analysis practices adopted by ADB and other multilateral development banks (MDBs). 1.1.3. This is the second release of the Guidelines. It incorporates results of a pilot testing exercise conducted during 2002 and 2003, a full technical review (completed in 2003), and further amendments to reflect ongoing activities associated with the Harmonization Agenda. 1 A matrix summarizing the second release amendments is provided under the “Revisions” tab. 1 In February 2003, a Harmonization Forum was jointly sponsored by five Multilateral Development Banks (MDBs) (African Development Bank, Asian Development Bank, European Bank for Reconstruction and Development, Inter-American Development Bank, and World Bank) and the Development Assistance Committee of the Organisation for Economic Co-operation and Development (OECD-DAC). All MDB presidents attended the meeting. The closing statement, the Rome Declaration on Harmonization, summarized progress and committed all participating institutions to specific activities to enhance harmonization. Subsequent to the Forum, the Islamic Development Bank joined the harmonization effort. In addition, an MDB Technical Working Group on Financial Management Harmonization was formed to foster increasing harmonization among the MDBs. [...]... matters to the whole department, and to undertake reviews of audited annual project accounts 1.7.3 The Financial Analysis Specialists (FASs) are based in project divisions Their focus is at the project level, particularly the financial analysis of investment projects (see Part 3 of the Guidelines) Financial Management and Analysis of Projects 2 2.1 User Instructions Overview 2.1.1 This part of the Guidelines... or that the general requirements apply to the project type APA = audited project accounts, PAI = Project Administration Instruction, AFS = agency financial statements Financial Management and Analysis of Projects User Instructions 12 of 12 2.11 Step 6: Project Completion 2.11.1 After the project facilities are completed and commissioned, ADB prepares a project completion report (PCR) to document the... Overview of Project Processing Steps 2.5.1 Once a project is identified by agreement between a government and ADB, it is processed and implemented The various steps from project identification to completion comprise what is known as the project cycle Further details and indicative timetables for the project cycle are available from www.adb.org/Projects/cycle.asp The steps in a typical ADB-financed project. .. the beginning of a program or project These guidelines strongly recommend that PPTA resources be used (in part) to appraise the financial aspects of Financial Management and Analysis of Projects User Instructions 4 of 12 projects and project executing agencies and, where necessary, to develop sufficient financial management capacity to implement and manage the project 2.4 Project Types and General Treatments... appropriate management and use of funds in ADB-funded projects, these Guidelines are intended to provide a framework for ADBs financial due diligence requirements throughout the ADB project cycle Thus, the Guidelines’ scope includes: • • • financial analysis of projects, project and entity financial management assessment, and auditing requirements for projects 1.3.2 The Guidelines’ due diligence framework... assistance to a DMC to help it identify and prepare a project for possible ADB financing The following table identifies relevant activities during project identification and early project preparation Financial Management and Analysis of Projects User Instructions 7 of 12 Responsibilitya Consultants and/ or Financial Executing Agency Analyst Activity • If project is not identified in the Country Strategy... by: establishing the norms for financial analysis and financial management of revenueearning and nonrevenue- earning projects for use during the project cycle; defining the financial management requirements for projects and project entities of borrowers, EAs, and other organizations charged with efficient use of funds provided by ADB; explaining to borrowers the project and institutional financial performance... Financial Management and Analysis of Projects 3 3.1 Preparing and Appraising Investment Project Investment Projects Overview 3.1.1 ADB appraises (reviews) investment projects to ensure that they are technically, financially, and economically viable It considers: (i) national, sectoral, and local needs for the investment; (ii) economic and financial justifications for the proposed project; (iii) sustainability;... guidance for all ADB projects irrespective of specific funding source modalities (Further guidance on due diligence in ADB private sector projects can also be accessed in the Private Sector Operations—Staff Instructions) The Guidelines provide specialized and appropriate financial analysis and financial management techniques to be utilized for all ADB projects and for every stage of the project cycle—CSP... access to ADB’s project financial management requirements to all interested parties 1.3.7 The Guidelines’ specific purpose is to provide ADB management, staff, and borrowers with an understandable, comprehensive and transparent directory of standards of financial analysis, and financial management for the implementation and operation of projects, including: Financial Management and Analysis of Projects 6 . Manual PAI Project Administration Instructions PAU Project Administration Unit PCR Project Completion Report PIU Project Implementing Unit (also IA) PMU Project Management Unit PPTA Project. 4.2.7. Project Objectives 4.2.8. Revenue-Earning Projects 4.2.9. Nonrevenue-Earning Projects 4.3. Financial Analysis 4.3.1. Introduction to Financial Analysis 4.3.2. Financial Analysis. project accounts. 1.7.3. The Financial Analysis Specialists (FASs) are based in project divisions. Their focus is at the project level, particularly the financial analysis of investment projects